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A Decent Earnings Season Thus Far

Contrary to fears coming into the fourth quarter earnings season, the earnings reports have actually been quite decent. They are not great, but they are not awful either, notwithstanding the strong negative reaction to Apple’s (AAPL) report.

Not only are positive surprises at levels better than the previous quarter and comparable to the last many, but neither are we getting much negative guidance from management teams. One could discount the positive surprises as largely a function of lowered expectation, which had sharply come down in the run up to the start of the earnings season. But the absence of negative guidance has to count as a net positive in an otherwise no-growth earnings environment.

Total earnings for the 136 S&P 500 companies that have already reported results are up +1% from the same period last year, with 62.5% of the companies beating expectations with a median surprise of +2.4%. Revenues are up +5.5%, with 52.9% of the companies beating top-line expectations and a median revenue surprise of +0.6%. Most of that revenue growth is coming from a handful Tech and Finance companies, including Apple, Google (GOOG) and Citigroup (C).

Combining the reports that have come out with the ones still to come, the composite fourth quarter earnings growth rate is essentially flat (up only +0.1%). The actual dollar amount of fourth quarter earnings is the lowest quarterly total in 2012 (see Table 5). But the expectation is for earnings growth to resume from the second quarter of 2013 and increase materially in the back half of the year. We have started expectations for 2013 come down a bit, but there is likely much more room to go.

Key Points

Total earnings for the 136 S&P 500 companies that have already reported results are up +1% from the same period last year, with 62.7% of the companies beating expectations and a median surprise of +2.4%. Total revenues are up +5.5%, with 52.9% of the companies beating expectations and a median surprise of +0.6%. The beat ratios and median surprises are better than the third quarter, but remain roughly in-line with historical levels.

Finance is the key driver of earnings growth, with total Finance sector earnings that have come out up +29.6% from the same period last year. Excluding Finance, total earnings growth for the reports that have come out would be down -6.8%.

Tech has been a laggard, with earnings growth almost non-existent and many of the industry leaders, including Apple (AAPL), Google (GOOG) and Microsoft (MSFT), coming short of revenue expectations.

Total earnings for the 364 companies that have still to report results are expected to be down -1.9%, with the remaining Finance and Tech companies accounting for most of the weakness.

Combining the results that have come out with those still to come, the composite earnings growth rate for the fourth quarter is +0.1%, which compares to -0.1% decline in the third quarter (down -0.1%). Excluding Finance, the composite fourth quarter earnings growth rate drops to a decline of -1.9%, compared to the decline of -4.1% for the ex-Finance group in the third quarter.

The Basic Materials sector is expected to have +9.5% higher earnings this quarter after back-to-back negative earnings growth in the last four quarters. The growth improvement in this economically sensitive sector is primarily due to easy comparisons as the overall backdrop remains challenging.

The low earnings growth trend is expected to carry over into the first quarter of 2013, but expectations are for significant improvement thereafter, particularly in the second half of 2013.

Net margins are essentially flat from the year-earlier period and down sequentially. Seven of the 16 Zacks sectors are expected to see margins contract in the quarter, including Tech. But margins are expected to improve back up in the first quarter.

For the full-year 2013, total earnings are expected to increase by +7.8% after the +2.3% gain in 2012. Total earnings are expected to be up +11.4% in 2014.